THINKING FAST AND SLOW

By Daniel Kahneman

EXPERTISE Expert intuition: The situation has provided a cue; this cue has

given the expert access to information stored in memory, and the information provides the answer.

Intuition is nothing more and nothing less than recognition. Valid intuitions develop when experts have learned to recognize familiar elements in a new situation and to act in a manner that is

appropriate to it.

EXPERTS VS. EQUAL PROBABILITY

Philip Tetlocks book "Expert Political Judgment: How Good Is It? How Can We Know?" - gathered more than 80,000 predictions.

The experts performed worse than they would have if they had simply assigned equal probabilities.

Even in the region they knew best, experts were not significantly better than non specialists.

People who spend their time, and earn their living , studying a particular topic produce poorer predictions than dart-throwing

monkeys.

STATE OF FLOWIt is much easier to strive for perfection when you are never bored. Flow neatly separates the two forms of effort: concentration on the

task and the deliberate control of attention.In a state of flow, maintaining focused attention on these

absorbing activities requires no exertion of self-control, thereby freeing resources to be directed to the task at hand.

BE IN A GOOD MOODPutting the participants in a good mood before the test by having them think happy

thoughts more than doubled accuracy.An even more striking result is that unhappy subjects were completely incapable of performing the intuitive task accurately; their guesses were no better than random. Mood evidently affects the operation of System 1: when we are uncomfortable and

unhappy, we lose touch with our intuition. When in a good mood, people become more intuitive and more creative but also less vigilant and more prone to logical

errors. Here again, as in the mere exposure effect, the connection makes biological sense. A good mood is a signal that things are generally going well, the environment is safe,

and it is all right to let one’s guard down. A bad mood indicates that things are not going very well, there may be a threat,

and vigilance is required.

SYSTEM 1 AND 2The main function of System 1 is to maintain and update a model

of your personal world, which represents what is normal in it.When System 2 is otherwise engaged, we will believe almost

anything. System 1 is gullible and biased to believe, System 2 is in charge of doubting and unbelieving, but System 2 is sometimes

busy, and often lazy. Understanding a statement must begin with an attempt to believe

it: you must first know what the idea would mean if it were true. Only then can you decide whether or not to unbelieve it. The initial attempt to believe is an automatic operation of System 1.

Unbelieving is an operation of System 2.

INTUITIONHerbert Simon’s definition of intuition: Expertise in a domain is not a single skill but rather a large collection of mini skills. The confidence that people have in their intuitions is not a reliable guide to their validity. In other words, do not trust anyone - including yourself – to tell you how much you should trust their judgment.Intuition cannot be trusted in the absence of stable regularities in the environment.

JUMPING TO CONCLUSIONSThe way to block errors that originate in System 1 is simple in principle: recognize the signs that you are in a cognitive minefield, slow down, and ask for reinforcement from System 2. Organizations are better than individuals when it comes to avoiding errors, because they naturally think more slowly and have the power to impose orderly procedures. Organizations can institute and enforce the application of useful checklists.

JUMPING TO CONCLUSIONSSystem 1 effortlessly originates impressions and feelings that are the main sources of the explicit beliefs and deliberate choices of System 2. The automatic operations of System 1 generate surprisingly complex patterns of ideas, but only the slower System 2 can construct thoughts in an orderly series of steps. You can also feel a surge of conscious attention whenever you are surprised. System 2 is activated when an event is detected that violates the model of the world that System 1 maintains.

JUMPING TO CONCLUSIONSWhen information is scarce, which is a common occurrence, System 1operates as a machine for jumping to conclusions. You did not start by asking, “What would I need to know before I formed an opinion about the quality of someone’s leadership?” System 1 got to work on its own from the first adjective.The combination of a coherence-seeking System 1 with a lazy System 2implies that System 2 will endorse many intuitive beliefs, which closely reflect the impressions generated by System 1. Based on brief exposure to photographs and without any political context: In about 70% of the races for senator, congressman, and governor, the election winner was the candidate whose face had earned a higher rating of competence.

CREATING A STORY (IN YOUR MIND)You cannot help dealing with the limited information you have as if it were all there is to know. You build the best possible story from the information available to you, and if it is a good story, you believe it. Paradoxically, it is easier to construct a coherent story when you know little, when there are fewer pieces to fit into the puzzle.Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance.

CREATING A STORY (IN YOUR MIND) Poor evidence can make a very good story. For some of our most important beliefs we have no evidence at all, except that people we love and trust hold these beliefs. Cognitive illusions can be more stubborn than visual illusions. What you learned about the Müller-Lyer illusion did not change the way you see the lines.Intuition adds value, but only after a disciplined collection of objective information and disciplined scoring of separate traits.

STATISTICS People are prone to apply causal thinking inappropriately, to situations that require statistical reasoning. Statistical thinking derives conclusions about individual cases from properties of categories and ensembles. Unfortunately, System 1 does not have the capability for this mode of reasoning; System 2 can learn to think statistically, but few people receive the necessary training. People should regard their statistical intuitions with proper suspicion and replace impression formation by computation whenever possible.

STATISTICS VS. YOUR MINDWe are prone to exaggerate the consistency and coherence of what we see. The exaggerated faith of researchers in what can be learned from a few observations is closely related to the halo effect, the sense we often get that we know and understand a person about whom we actually know very little. Bad schools also tend to be smaller than average. The truth is that small schools are not better on average; they are simply more variable.

RISKA basic limitation in the ability of our mind to deal with small risks: we either ignore them altogether or give them far too much weight - nothing in between.When an unlikely event becomes the focus of attention, we will assign it much more weight than its probability deserves.Reducing or mitigating the risk is not adequate; to eliminate the worry the probability must be brought down to zero. People overestimate the probabilities of unlikely events. People overweight unlikely events in their decisions.

PRIMING / ANCHORING Your actions and your emotions can be primed by events of which you are not even aware.

The common admonition to “act calm and kind regardless of how you feel” is very good advice: You are likely to be rewarded by actually feeling calm and kind.

MONEY PRIMINGMoney-primed people become more independent than they would be without the associative trigger. They persevered almost twice as long in trying to solve a very difficult problem before they asked the experimenter for help, a crisp demonstration of increased self-reliance. Money-primed people are also more selfish: they were much less willing to spend time helping another student who pretended to be confused about an experimental task. When an experimenter clumsily dropped a bunch of pencils on the floor, the participants with money (unconsciously) on their mind picked up fewer pencils.Money-primed undergraduates also showed a greater preference for being alone. The general theme of these findings is that the idea of money primes individualism: a reluctance to be involved with others, to depend on others, or to accept demands from others.

BRAINWASH?Feeling that one’s soul is stained appears to trigger a desire to cleanse one’s body. A reliable way to make people believe in falsehoods is frequent repetition, because familiarity is not easily distinguished from truth. Words that were presented more frequently were rated much more favourably than the words that had been shown only once or twice.

AVAILABILITY HEURISTIC The experience of familiarity has a simple but powerful quality of ‘pastness’ that seems to indicate that it is a direct reflection of prior experience. This quality of pastness is an illusion.

A name you've seen before will look familiar when you see it because you will see it more clearly. Words that you have seen before become easier to see again - you can identify them better than other words when they are shown very briefly or masked by noise, and you will be quicker (by a few hundredths of a second) to read them than to read other words. In short, you experience greater cognitive ease in perceiving a word you have seen earlier, and it is this sense of ease that gives you the impression of familiarity.

AVAILABILITY HEURISTIC …like other heuristics of judgment, substitutes one question for another: you wish to estimate the size of a category or the frequency of an event, but you report an impression of the ease with which instances come to mind.

Discover how the heuristic leads to biases by following a simple procedure: list factors other than frequency that make it easy to come up with instances. Each factor in your list will be a potential source of bias. People are less confident in a choice when they are asked to produce more arguments to support it.

ANCHORING EFFECTAnchoring effect. It occurs when people consider a particular value for an unknown quantity before estimating that quantity. What happens is one of the most reliable and robust results of experimental psychology: the estimates stay close to the number that people considered. The same house will appear more valuable if its listing price is high than if it is low, even if you are determined to resist the influence of this number. Any number that you are asked to consider as a possible solution to an estimation problem will induce an anchoring effect.

STEREOTYPESStereotypes are statements about the group that are (at least tentatively) accepted as facts about every member. Here are two examples: Most of the graduates of this inner-city school go to college. Interest in cycling is widespread in France.You will be reminded of these facts when you think about the likelihood that a particular graduate of the school will attend college, or when you wonder whether to bring up the Tour de France in a conversation with a Frenchman you just met. Stereotyping is a bad word in our culture, but in my usage it is neutral. One of the basic characteristics of System 1 is that it represents categories as norms and prototypical exemplars.

HOW TO DISCIPLINE INTUITIONYou should not let yourself believe whatever comes to your mind. To be useful, your beliefs should be constrained by the logic of probability.Base rates matter, even in the presence of evidence about the case at hand. Intuitive impressions of the diagnosis of evidence are often exaggerated. Anchor your judgment of the probability of an outcome on a plausible base rate. Question the diagnose of your evidence.

PREDICTIONSEliminating redundancy from your sources of information is always a good idea. The magic of error reduction works well only when the observations are independent and their errors uncorrelated. If the observers share a bias, the aggregation of judgments will not reduce it. Allowing the observers to influence each other effectively reduces the size of the sample, and with it the precision of the group estimate. To derive the most useful information from multiple sources of evidence, you should always try to make these sources independent of each other.

CAUSALOur mind is strongly biased toward causal explanations.Students “quietly exempt themselves” (and their friends and acquaintances) from the conclusions of experiments that surprise them. When they presented their students with a surprising statistical fact, the students managed to learn nothing at all. But when the students were surprised by individual cases - two nice people who had not helped - they immediately made the generalization.

SURPRISINGCases Surprising individual cases have a powerful impact and are a more effective tool for teaching psychology because the incongruity must be resolved and embedded in a causal story.You are more likely to learn something by finding surprises in your own behaviour than by hearing surprising facts about people in general. The explanatory stories that people find compelling are simple; are concrete rather than abstract; assign a larger role to talent, stupidity, and intentions than to luck; and focus on a few striking events that happened rather than on the countless events that failed to happen.

RANDOMNESSSuccess = talent + luck Great Success = a little more talent + a lot of luck The idea that the future is unpredictable is undermine every day by the ease with which the past is explained . The idea that large historical events are determined by luck is profoundly shocking, although it is demonstrably true. The line that separates the possibly predictable future from the unpredictable distant future is yet to be drawn.

 INVESTING  A venture capitalist will never be told that the probability of success for a start-up in its early stages is “very high.” When a venture capitalist looks for “the next big thing,” the risk of missing the next Google or Facebook is far more important than the risk of making a modest investment in a start-up that ultimately fails. The goal of venture capitalists is to call the extreme cases correctly, even at the cost of overestimating the prospects of many other ventures.

 BUYERS & SELLERS The buyers and sellers know that they have the same information; they exchange the stocks primarily because they have different opinions. If all assets in a market are correctly priced, no one can expect either to gain or to lose by trading. Perfect prices leave no scope for cleverness, but they also protect fools from their own folly.For the large majority of individual investors, taking a shower and doing nothing would have been a better policy than implementing the ideas that came to their minds.

PAST EVENTSI have heard of too many people who “knew well before it happened that the 2008 financial crisis was inevitable.” When an unpredicted event occurs, we immediately adjust our view of the world to accommodate the surprise.We have an imperfect ability to reconstruct past states of knowledge.

THE BUSINESS BOOK “FIX”The illusion that one has understood the past feeds the further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety that we would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. We all have a need for the reassuring message that actions have appropriate consequences, and that success will reward wisdom and courage. Many business books are tailor-made to satisfy this need.

SKILLA basic test of skill: persistent achievement. The diagnostic for the existence of any skill is the consistency of individual differences in achievement. The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions - and thereby threaten people’s livelihood and self- esteem - are simply not absorbed. The mind does not digest them.Skill in evaluating the business prospects of a firm is not sufficient for successful stock trading, where the key question is whether the information about the firm is already incorporated in the price of its stock. Traders apparently lack the skill to answer this crucial question, but they appear to be ignorant of their ignorance.

THE MEASURE OF WEALTHDaniel Bernoulli argued that a gift of 10 ducats has the same utility to someone who already has 100 ducats as a gift of 20 ducats to someone whose current wealth is 200 ducats.The psychological response to a change of wealth is inversely proportional to the initial amount of wealth.A decision maker with diminishing marginal utility for wealth will be risk averse.

RISK & UTILITYIn mixed gambles, where both a gain and a loss are possible, loss aversion causes extremely risk-averse choices. In bad choices, where a sure loss is compared to a larger loss that is merely probable, diminishing sensitivity causes risk seeking. Diminishing marginal utility: the more leisure you have, the less you care for an extra day of it, and each added day is worth less than the one before. Similarly, the more income you have, the less you care for an extra dollar, and the amount you are willing to give up for an extra day of leisure increases. A mistaken assumption: that your utility for a state of affairs depends only on that state and is not affected by your history.

“FOR EXCHANGE” When you shop for shoes, the merchant who gives up the shoes in exchange for money certainly feels no loss. Indeed, the shoes that he hands over have always been, from his point of view, a cumbersome proxy for money that he was hoping to collect from some consumer. Furthermore, you probably do not experience paying the merchant as a loss, because you were effectively holding money as a proxy for the shoes you intended to buy. Both the shoes the merchant sells you and the money you spend from your budget for shoes are held “for exchange.”They are intended to be traded for other goods. Other goods, such as wine and Super Bowl tickets, are held “for use,” to be consumed or otherwise enjoyed.

THE GAMBLING MANTRA Rehearse the mantra that will get you significantly closer to economic rationality: ‘you win a few, you lose a few.’The main purpose of the mantra is to control your emotional response when you do lose. The mantra works when the gambles are genuinely independent of each other; it does not apply to multiple investments in the same industry, which would all go bad together. It works only when the possible loss does not cause you to worry about your total wealth. If you would take the loss as significant bad news about your economic future, watch it! It should not be applied to long shots, where the probability of winning is very small for each bet. If you have the emotional discipline that this rule requires, you will never consider a small gamble in isolation or be loss averse for a small gamble.

IN THE SHORT TERM…Broad framing blunted the emotional reaction to losses and increased the willingness to take risks. The combination of loss aversion and narrow framing is a costly curse. Individual investors can avoid that curse, achieving the emotional benefits of broad framing while also saving time and agony, by reducing the frequency with which they check how well their investments are doing. Closely following daily fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains.The deliberate avoidance of exposure to short-term outcomes improves the quality of both decisions and outcomes.

INVESTING WRAP-UP Money is a proxy for points on a scale of self-regard and achievement. Finance research has documented a massive preference for selling winners rather than losers - a bias that has been give nan opaque label: the disposition effect. The disposition effect is an instance of narrow framing. The investor has set up an account for each share that she bought, and she wants to close every account as a gain. A rational agent would have a comprehensive view of the portfolio. The sunk-cost fallacy keeps people for too long in poor jobs, unhappy marriages, and unpromising research projects.

ALGORITHMSEach of these domains entails a significant degree of uncertainty and unpredictability. We describe them as “low-validity environments.” In every case, the accuracy of experts was matched or exceeded by a simple algorithm.

CLINICAL VS. STATISTICAL PREDICTION PT. 1Orley Ashenfelter has offered a compelling demonstration of the power of simple statistics to outdo world-renowned experts. Ashenfelter wanted to predict the future value of fine Bordeaux wines from information available in the year they are made. Ashenfelter converted that conventional knowledge into a statistical formula that predicts the price of a wine - for a particular property and at a particular age - by three features of the weather: the average temperature over the summer growing season, the amount of rain at harvest-time, and the total rainfall during the previous winter. His formula provides accurate price forecasts years and even decades into the future. Indeed, his formula forecasts future prices much more accurately than the current prices of young wines do.

CLINICAL VS. STATISTICAL PREDICTION PT. 2Ashenfelter’s formula is extremely accurate - the correlation between his predictions and actual prices is above .90. Why are experts inferior to algorithms? One reason, which Meehl suspected, is that experts try to be clever, think outside the box, and consider complex combinations of features in making their predictions. Complexity may work in the odd case, but more often than not it reduces validity. Simple combinations of features are better. Human decision makers are inferior to a prediction formula even when they are given the score suggested by the formula! They feel that they can overrule the formula because they have additional information.

TO MAXIMIZE PREDICTIVE ACCURACY… Final decisions should be left to formulas, especially in low-validity environments. It is possible to develop useful algorithms without any prior statistical research. Simple equally weighted formulas based on existing statistics or on common sense are often very good predictors of significant outcomes.Marital stability is well predicted by a formula: frequency of lovemaking minus frequency of quarrels.

TO HIRE THE BEST POSSIBLE PERSON…First, select a few traits that are prerequisites for success in this position (technical proficiency, engaging personality, reliability, and so on). Don’t overdo it - six dimensions is a good number.The traits you choose should be as independent as possible from each other, and you should feel that you can assess them reliably by asking a few factual questions. Next, make a list of those questions for each trait and think about how you will score it, say on a 1–5 scale.Collect the information on one trait at a time, scoring each before you move on to the next one. Do not skip around. To evaluate each candidate, add up the six scores. Firmly resolve that you will hire the candidate whose final score is the highest, even if there is another one whom you like better - try to resist your wish to invent broken legs to change the ranking.

OUTSIDE VIEWBaseline prediction: the prediction you make about a case if you know nothing except the category to which it belongs. The baseline prediction should be the anchor for further adjustments. People who have information about an individual case rarely feel the need to know the statistics of the class to which the case belongs.

THE PLANNING FALLACYThe prevalent tendency to underweight or ignore distributional information is perhaps the major source of error in forecasting. Planners should therefore make every effort to frame the forecasting problem so as to facilitate utilizing all the distributional information that is available. This may be considered the single most important piece of advice regarding how to increase accuracy in forecasting through improved methods. The greatest responsibility for avoiding the planning fallacy lies with the decision makers who approve the plan. If they do not recognize the need for an outside view, they commit a planning fallacy.

OPTIMISTSOptimistic individuals play a disproportionate role in shaping our lives. Their decisions make a difference; they are the inventors, the entrepreneurs, the political and military leaders - not average people.They got to where they are by seeking challenges and taking risks. They are talented and they have been lucky, almost certainly luckier than they acknowledge.The people who have the greatest influence on the lives of others are likely to be optimistic and overconfident, and to take more risks than they realize.These persistent (or obstinate) individuals doubled their initial losses before giving up. Significantly, persistence after discouraging advice was relatively common among inventors who had a high score on a personality measure of optimism.

ENTREPRENEURIAL OPTIMISMI have had several occasions to ask founders and participants in innovative start-ups a question: To what extent will the outcome of your effort depend on what you do in your firm? This is evidently an easy question; the answer comes quickly and in my small sample it has never been less than 80%. Even when they are not sure they will succeed, these bold people think their fate is almost entirely in their own hands. They are surely wrong: the outcome of a start-up depends as much on the achievements of its competitors and on changes in the market as on its own efforts. However, entrepreneurs naturally focus on what they know best - their plans and actions and the most immediate threats and opportunities , such as the availability of funding. They know less about their competitors and therefore find it natural to imagine a future in which the competition plays little part.

CAN A CFO FORECAST THE S&P?A survey in which the chief financial officers of large corporations estimated the returns of the Standard & Poor’s index over the following year. The Duke scholars collected 11,600 such forecasts and examined their accuracy. The conclusion was straightforward: financial officers of large corporations had no clue about the short-term future of the stock market; the correlation between their estimates and the true value was slightly less than zero! When they said the market would go down, it was slightly more likely than not that it would go up.

PREMORTEM When the organization has almost come to an important decision but has not formally committed itself, Klein proposes gathering for a brief session a group of individuals who are knowledgeable about the decision. The premise of the session is a short speech: “Imagine that we are a year into the future.We implemented the plan as it now exists. The outcome was a disaster. Please take 5 to 10 minutes to write a brief history of that disaster.”Premortem has two main advantages: it overcomes the groupthink that affects many teams once a decision appears to have been made, and it unleashes the imagination of knowledgeable individuals in a much-needed direction.

LOSSESA single cockroach will completely wreck the appeal of a bowl of cherries, but a cherry will do nothing at all for a bowl of cockroaches.Bad emotions, bad parents, and bad feedback have more impact than good ones, and bad information is processed more thoroughly than good.The self is more motivated to avoid bad self-definitions than to pursue good ones.Bad impressions and bad stereotypes are quicker to form and more resistant to disconfirmation than good ones.

ASYMMETRY OF LOSSLoss aversion creates an asymmetry that makes agreements difficult to reach. The concessions you make to me are my gains, but they are your losses; they cause you much more pain than they give me pleasure. Inevitably, you will place a higher value on them than I do.Negotiators often pretend intense attachment to some good. Although they actually view that good as a bargaining chip and intend ultimately to give it away in an exchange. Because negotiators are influenced by a norm of reciprocity, a concession that is presented as painful calls for an equally painful (and perhaps equally inauthentic) concession from the other side.

DON’T REGRET ACTIONPeople expect to have stronger emotional reactions (including regret) to an outcome that is produced by action than to the same outcome when it is produced by inaction. Be explicit about the anticipation of regret. People generally anticipate more regret than they will actually experience, because they underestimate the efficacy of the psychological defences they will deploy - which they label the “psychological immune system.” Their recommendation is that you should not put too much weight on regret; even if you have some, it will hurt less than you now think.

GAMBLINGWould you accept a gamble that offers a 10% chance to win $95 and a 90% chance to lose $5? Would you pay $5 to participate in a lottery that offers a 10% chance to win $100 and a 90% chance to win nothing? A bad outcome is much more acceptable if it is framed as the cost of a lottery ticket that did not win than if it is simply described as losing a gamble.We should not be surprised: losses evokes stronger negative feelings than costs.

EXPERIENCINGConfusing experience with the memory of it is a compelling cognitive illusion - and it is the substitution that makes us believe a past experience can be ruined. The experiencing self does not have a voice.The remembering self is sometimes wrong, but it is the one that keeps score and governs what we learn from living, and it is the one that makes decisions. What we learn from the past is to maximize the qualities of our future memories, not necessarily of our future experience.

WHAT IS YOUR EMOTIONAL STATEOur emotional state is largely determined by what we attend to, and we are normally focused on our current activity and immediate environment .To get pleasure from eating, for example, you must notice that you are doing it .Americans were far more prone to combine eating with other activities, and their pleasure from eating was correspondingly diluted.

GOALSgoals make a large difference. Nineteen years after they stated their financial aspirations, many of the people who wanted a high income had achieved it. Each additional point on the money-importance scale was associated with an increment of over $14,000 of job income.The goals that people set for themselves are so important to what they do and how they feel about it that an exclusive focus on experienced well-being is not tenable. We cannot hold a concept of well-being that ignores what people want. Nothing in life is as important as you think it is when you are thinking about it.

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